Financial analysts and the financial media often refer to U.S. Treasury bonds (T-bonds) as risk-free investments. And it's true. The United States government has never defaulted on a debt or missed a payment on a debt. You would have to envision the utter collapse of the government to find a scenario that would involve losing any of the principal invested in a T-bond.
Key Takeaways
- There is virtually zero risk that you will lose principal by investing in T-bonds.
- There is a risk that you could have earned better money elsewhere.
- Investing decisions are always a tradeoff between risk and reward.
The crucial word above is "principal." In investing, the safest investments have the lowest returns. And accepting a low return is in itself a risky decision.
Understanding U.S. Treasury Bond Risk
Most investments in debt, from corporate bonds to mortgage-backed securities, carry some degree of default risk. The investor accepts the risk that the borrower will be unable to keep up the interest payments or return the principal invested.
In the event of bankruptcy, bondholders are first in line before other investors, but that's no guarantee of full repayment.
This is not true for T-bonds, which are backed by "the full faith and credit" of the U.S. government. That means the Federal Reserve. Investors know that the Treasury Department will pay them back even if the Fed's balance sheet is ugly.
So, the risks to investing in T-bonds are opportunity risks. That is, the investor might have gotten a better return elsewhere, and only time will tell. The dangers lie in three areas: inflation, interest rate risk, and opportunity costs.
Inflation
Every economy experiences inflation from time to time, to one degree or another. T-bonds have a low yield, or return on investment. A little bit of inflation can erase that return, and a little more can effectively eat into your savings.
That is, an investment of $1,000 in a T-bond for one year at 1% interest would get you $1,010. But if inflation was 2%, the initial investment when it is returned will have the buying power of a little under $990.
Interest Rate Risk
When interest rates rise, the market value of debt securities tends to drop. This makes it difficult for the bond investor to sell a T-bond without losing on the investment.
Opportunity Costs
All financial decisions, even T-bond investments, carry opportunity costs.
An investor who purchases a $1,000 T-bond loses the chance to invest or spend that $1,000 elsewhere. The investor might have been better off putting $1,000 into an exchange-traded fund (ETF) that offered a greater potential for return along with a greater risk of principal loss. For that matter, the investor might have bought a new laptop for $1,000. If inflation continues at its current pace, that model will cost $1,025 a year from now.
FAQs
But while they are lauded for their security and reliability, potential drawbacks such as interest rate risk, low returns and inflation risk must be carefully considered. If you're interested in investing in Treasury bonds or have other questions about your portfolio, consider speaking with a financial advisor.
What is the downside to buying Treasury bonds? ›
Inflation. Every economy experiences inflation from time to time, to one degree or another. T-bonds have a low yield, or return on investment. A little bit of inflation can erase that return, and a little more can effectively eat into your savings.
What is the disadvantage of investing in treasury bills? ›
This means that investors looking for high returns may not find T-bills attractive. Since T-bills have fixed interest rates, inflation can erode the purchasing power of the returns earned from these investments. This means that investors may need help to keep up with inflation, resulting in a decline in real returns.
Is there a high risk for investing money in U.S. Treasury bills? ›
T-bills are known to be low-risk short-term investments when held to maturity since the U.S. government guarantees them. Investors owe federal taxes on any income earned but no state or local tax.
What are the three major risks when investing in bonds? ›
- Credit Risk — The risk that a bond's issuer will go into default before a bond reaches maturity.
- Market Risk — The risk that a bond's value will fluctuate with changing market conditions.
- Interest Rate Risk — The risk that a bond's price will fall with rising interest rates.
What causes bond prices to fall? Bond prices move in inverse fashion to interest rates, reflecting an important bond investing consideration known as interest rate risk. If bond yields decline, the value of bonds already on the market move higher. If bond yields rise, existing bonds lose value.
Do you pay taxes on Treasury bonds? ›
Interest income from Treasury securities is subject to federal income tax but exempt from state and local taxes. Income from Treasury bills is paid at maturity and, thus, tax-reportable in the year in which it is received.
Why people don t invest in Treasury bill? ›
Taxes: Treasury bills are exempt from state and local taxes but still subject to federal income taxes. That makes them less attractive holdings for taxable accounts. Investors in higher tax brackets might want to consider short-term municipal securities instead.
Are Treasury bills better than CDs? ›
If you're saving for a goal less than a year away: If you're saving money for a goal with a short-time horizon, T-bills can make more sense than CDs. They provide a higher APY than savings accounts, and they're more liquid than CDs.
Can Treasury bills lose value? ›
T-bills pay a fixed rate of interest, which can provide a stable income. However, if interest rates rise, existing T-bills fall out of favor since their return is less than the market. T-bills have interest rate risk, which means there is a risk that existing bondholders might lose out on higher rates in the future.
Treasury bonds have maturities of 20 or 30 years and pay interest every six months. In contrast, Treasury bills have much shorter maturities, from a few days to 52 weeks. Treasury bills are sold at a discount to their face value and do not pay interest before maturity.
Can you lose money on bonds if held to maturity? ›
If you're holding the bond to maturity, the fluctuations won't matter—your interest payments and face value won't change. But if you buy and sell bonds, you'll need to keep in mind that the price you'll pay or receive is no longer the face value of the bond.
Should I buy 10 year Treasury bonds? ›
Whether 10-year Treasurys are a good investment for you depends on your investment goal. If your goal is to let your money grow slowly and conservatively over time, Treasury notes are considered a low-risk investment if held to maturity since they're backed by the U.S. government.
What are the riskiest bonds to invest in? ›
Corporate bonds
These debt securities allow companies to raise capital when they need it while providing a return to investors. Investments in corporate bonds carry more risk than Treasury bonds since they aren't backed by the U.S. government.
Why are bonds not a good investment? ›
Bonds are sensitive to interest rate changes.
Bonds have an inverse relationship with the Fed's interest rate. When interest rates rise, bond prices fall. And when the interest rate is slashed, bond prices tend to rise. Surprise increases or decreases could create temporary instability.
Can I lose money on a fixed rate bond? ›
You're unlikely to lose money on a fixed rate bond, but if savings rates rise while your money is locked away at a lower rate, you could end up feeling you've lost out on interest in better paying savings accounts. You can also face a penalty should you need to withdraw your money early.
Is it a good idea to invest in treasury I bonds? ›
I bonds are great, safe investments. But they're paid out at the end of their 30-year maturities. Yes, you can cash them in after 12 months. If you redeem an I bond within five years of purchase, however, you forfeit the last three months' interest.
Is it better to buy Treasury bills or bonds? ›
U.S. Bonds vs. Bills vs. Notes: An Overview
Bonds typically mature in 20-30 years and offer investors the highest interest payments to maturity. T-notes mature anywhere between two and 10 years, with bi-annual interest payments, while T-bills have the shortest maturity terms—from four weeks to a year.
What happens to Treasury bonds when interest rates rise? ›
When rates go up, bond prices typically go down, and when interest rates decline, bond prices typically rise. This is a fundamental principle of bond investing, which leaves investors exposed to interest rate risk—the risk that an investment's value will fluctuate due to changes in interest rates.
